Charles Schwab Experts Advise Keeping Municipal Bonds in Taxable Accounts

Charles Schwab investment experts said municipal bonds should be held in taxable accounts rather than in tax-advantaged accounts [1, 2].

This guidance matters because the placement of assets can significantly impact the final return for high-income investors. By strategically choosing where to hold specific assets, investors may avoid wasting the unique tax benefits associated with municipal securities.

The core of the recommendation rests on the concept of after-tax yield. Municipal bonds are typically exempt from federal income taxes, and in some cases, state and local taxes as well ^[2]. When these bonds are placed inside a tax-advantaged account, such as a 401(k) or an IRA, the tax-exempt status of the bond is redundant because the account itself already provides tax deferral or tax-free growth [1, 2].

For high-income earners, the tax advantage of municipal bonds is most potent when the bonds are held in a standard taxable brokerage account. In such accounts, the interest earned on municipal bonds remains tax-free, which effectively increases the after-tax yield compared to holding a taxable bond in the same account ^[2].

Conversely, using limited space in a tax-advantaged account for municipal bonds may be inefficient. Experts said that these accounts are better suited for assets that would otherwise generate significant taxable income, such as corporate bonds or REITs ^[1]. This approach allows the investor to maximize the tax-shielding capabilities of the retirement account while still benefiting from the tax-free nature of municipal bonds in their taxable holdings ^[2].

This strategy focuses on the overall tax efficiency of a portfolio across all account types. By aligning the asset's tax characteristics with the account's tax status, investors can potentially increase their net wealth without increasing their risk profile [1, 2].